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Retirement: Save now or pay later

Americans love to spend and hate to save. Such a statement may sound cliche, but statistics prove it -- especially when it comes to saving for retirement.

Scott Below, chair and associate professor in the Department of Finance at East Carolina University in Greenville, N.C., says workers are not entirely to blame for their reluctance to save. In the first part of a two-part interview, he says educators and the government must do a better job of helping Americans see that starting early on retirement planning can pay huge dividends later in life.

America's retirement crisis is well-documented. Why do you suppose this is a problem?

Americans are the ultimate consumers, and that definitely plays a role. But I also think education -- or lack thereof -- is a big factor. Most people don't understand the basic concepts of personal financial planning, largely because they're not widely taught in our high schools or even our colleges and universities.

For example, the importance of starting to save for retirement early is something I stress in my college courses because it's such a critical concept, but also because the audience, mostly in their early 20s, is the perfect age to hear that message.

I show them if they begin funding an (individual retirement account) with $3,000 per year at age 20 and continue on through age 65, they will wind up with $2.5 million at retirement (assuming they earn the long-run annual compound growth rate in stocks, which was 9.88 percent from 1926 to 2011). Not a bad result for investing only $3,000 a year.

Then I show them what happens if they wait to start funding that IRA until age 30. All they would be missing is those first 10 years of investments at $3,000 a year, which doesn't sound like it would make much difference. But when we crunch the numbers, they find out that by waiting until age 30, the IRA winds up being worth only a little more than $958,000 at age 65. That means the $3,000 a year they didn't invest in their 20s winds up costing them more than $1.5 million at age 65! That's a pretty powerful result, and it gets their attention.

It's not like the power of compounding is rocket science, yet so few people understand how powerful it can be … assuming you can give it sufficient time to work. If you're older when you start saving, compounding won't be able to do as much of the work for you, and you'll need to do more yourself. That means investing a larger portion of (your) paycheck each month, which we know Americans have a tough time doing.

As educators, we're partly to blame for the information gap on things like the importance of starting early. We need to do a better job getting the word out. But the government shoulders some of the blame, too, by creating retirement savings vehicles that are more complicated and expensive than they should be and then doing next to nothing in the way of educating citizens about how and why they should use them.

What can Americans do to improve their retirement prospects at various points in their careers?

Always fund your retirement account first. Once you've maxed out your retirement contribution in a given year, then go wild. Go ahead and buy that 70-inch flat-screen TV or whatever toys you've had your eye on, but do it after you've funded your retirement account. In addition, try to cut back on the kinds of major purchases that put you in debt.

Do you really need a new car every three or four years? My SUV is 15 years old, still runs great and has been paid (off) for 10 years. Sure, I could buy a new car, but why? The old one doesn't cost me a dime in interest payments, the insurance premiums are low because it's only worth a fraction of what it cost new, and to this point, it has been very reliable. We'll eventually have to get a new car, but not until we've gotten as much out of the old one as we possibly can.

Housing is another area where people often wind up plowing way too much money into interest payments as opposed to their retirement accounts. People often buy homes that are two or three times larger than they realistically need, which is a big waste of money.

The truth is, large debt obligations keep people from fully funding their retirement accounts, saddling them with large payments today and inadequate savings at retirement. Let's face it: If your paycheck barely covers the monthly bills, the retirement account isn't getting funded.

Also, don't view your house as a retirement investment. At best, homeowners should expect to break even with inflation, even after several decades in the same home. Studies show that from a purely financial perspective, you're better off renting your whole life rather than buying a home, assuming you invest the difference between what you would save on renting versus homeownership.

The biggest advantage of owning versus renting is the mortgage payment acts as a forced savings account. So while homes aren't good investments in terms of getting growth over and above inflation, homeownership at least forces Americans -- who tend to spend first and save last -- to put money into something that probably isn't going to lose value over time.

Finally, it is critical to educate yourself. There are plenty of excellent resources on retirement investing for those willing to make the effort. Unfortunately, there is also plenty of bad advice out there.

I'd recommend looking for a financial planner who either gets paid by the hour or charges a flat fee based on assets under management. Both of those types of advisers can also earn sales commissions, however, so be sure to ask for a disclosure document specifying exactly how they're being compensated.

We would like to thank Scott Below, chair and associate professor in the Department of Finance at East Carolina University in Greenville, N.C., for his insights. Questions for this interview were contributed by Barbara Whelehan, assistant managing editor at Bankrate.com.